Portfolio Re-Structuring/25% CAGR quality-growth for next 2-3 years

[Donald]

This is topical now, and probably of interest to explore for most folks visiting VP. Unfortunately, we cannot have the luxury of an updated VP Public Portfolio every 6 months.

So here’s the next best thing.
A live portfolio (as of close 18 Jan 2016) of someone following/mirroring the VP Portfolio philosophy closely from around Oct 2013. There are the usual Long Term Portfolio candidates, also Opportunistic Portfolio candidates that you can spot like Avanti Feeds, Canfin Homes, Welspun Syntex, besides stable Compounders like GRUH.

Even with the recent carnage, this looks to be a pretty resilient portfolio. Probably an Outperformer Portfolio as any, over the last 2 years plus, from Oct 2013. Anyone will be happy to take that, I guess.

Question is, how do we make sure this Portfolio stays as resilient, as performant over the next 2-3-5 years, through probably more such market troughs and peaks??

[Donald]

Now, first things first. We need to make sure we do not violate SEBI Guidelines

1. Let’s make sure, we DO NOT reduce this thread to a RECOMMENDATION exercise
2. Let’s make sure we treat this as an illustrative exercise to demonstrate Portfolio Re-Structuring
3. Let’s make sure we use this thread as part of our many Investment Strategy pointers
4. Let’s not put VP Core Team on the spot to justify Allocations in this Portfolio. This is a representative one as any, and based on an individual’s own homework/conviction

Allow us to conduct the discussion in a manner that addresses the concerns that are uppermost in our minds today - explore a) what’s unfolding in our markets, b) understand investor psychology and behaviour c) come up with appropriate responses to deal with that

[Donald]

Markets in transition?
Prashant Jain, Hindu BusinessLine Jan 10
Prashant Jain HDFC is of the view, that this current pain is the way for market forces to abandon what has worked for last cycle, to adopting something new.

The markets are also in transition. Transition means that you give up something which has worked for last cycle – in this case FMCG, pharmaceuticals, etc and adopt something new. This will take time as there is reluct-ance to adopt something new, to give up what has worked in the past. This can cause some pain in the short to medium term.

Despite this, I am positive about the economy and markets. It has been observed in the past that whenever Indian markets have corrected around reasona-ble valuations driven by external factors, they have proved opportunities in disguise.

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And again elaborates more on this Market Transition, here

Prashant Jain CNBC TV 18 Jan 14

*A: I think the economy and the market to my mind are in transition. So, the economy is coming out of a very high inflation phase, very high current account deficit, a phase in which currency depreciated 40-50 percent, a phase in which capital expenditure was extremely weak and a phase in which fiscal deficit was going up and it supported consumption. The earnings growth was limited to very few sectors, basically linked to consumption or to exporters or to retail oriented banks. Therefore, I think, since market always loves sustained growth or wherever there is growth, you tend to crowd in there, I think these sectors have become quite expensive to my mind. *

When I look at the next one, two, three or five years, I think all these factors are changing. So, high inflation has become low inflation. Your foreign direct investor (FDI) inflows are more than the current account deficit of the country after a long time. Fiscal deficit is moderating, inflation is down, interest rates have come down a bit – I think they should go down more and I think there are definitive signs about a strong recovery in capital expenditure over the next few years. I think it will be lead by infrastructure space, by government spending, private capital expenditure will follow maybe after few quarters. Therefore, when I look at where the markets are today, I think they are in transition. I think the leadership in these markets will change. I look at this fall as a process of that leadership change. So, when market recovers, it will not be the leaders of the last few years which will outperform but a new leadership should emerge. I think these sectors will be related to capital expenditure.

[whipsaw]

Thanks for sharing. This gives the fellow VPs a sense of reassurance, that if you have bought good companies at a decent price and conviction to hold for long term , you can sit through these market carnage with less anxiety.

May I ask why biggest (& disproportionate) allocation to Shilpa? Is it for the element of big surprise in FY17? Going by what Prashant Jain said for leadership change, going forward, should it carry the same weight in the VP portfolio? Or should we just stick to individual stock picking not worrying about sectors/leaders etc.

[Donald]

Disclaimer:
This thread is probably NOT for the Purists, those who already live by a well-set Investment Philosophy, those who have probably seen through at least a couple of bull-bear-bull cycles.

This thread IS for Learners like me, who want to remain flexible, want to remain curious, want to understand markets and investor behaviour, and attempt to adopt strategies successfully executed by folks we trust and respect, who we have seen being there, doing that.

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As thinking practitioners of the ART of investing, we have found the need to re-calibrate our Portfolios from time to time. As we experience more, we become more alert to shifts in Market cycles.
I still remember in early 2012 on our Gujarat trip. Ayush & Hitesh would keep talking about Pharma boom being all over the place, and I had absolutely no clue

In early 2014, I was acutely aware of the need to shift from a completely aggressive small cap portfolio, to one that could lend more stability in times of market shifts, end hence allocated 25% of Portfolio to stabilisers like HDFC, GRUH. Think that made a huge difference to my Portfolio weathering this current carnage with calmness. We also made sure to add 2-3 new Opportunistic Bets every year (again, some 25% of Portfolio) where we found the growth visibility very strong and no-brainer valuations (big gaps between Performance & Perception) like as in Canfin Homes, Avanti Feeds, Welspun Syntex, and the like. These added the extra kickers that ensured a more robust outperformance, while leaving us free to allocate some 50% to long-term high-growth compounders.

On the other hand, I have always marvelled at VP’s own Peter Lynch (coined by Hiteshbhai) - Ayush’s family stabilising plank of a stream of Opportunistic bets every year. They have never needed to shift to Large Caps/Defensives/Highest Quality. They just sort of roll-over some significant money to a new set of Opportunities every year - where the Growth/Visibility seems pretty strong - and that is something that obviously the Defensives can never match :). Of course their’s is also a much more diversified portfolio strategy.

Now I am always greedy about exploring smarter compounding.
Is there a way to adopt part of this strategy to restructure our Portfolios, better??
I have observed over last 2-3 years, when we play this game well, it is almost as good as the Defensive planks in your Portfolio, even in times of churn. Actually if we play concentrated and do the hard work of getting insights to choosing the best stable growers among the new opportunities, we end outperforming by some margin. At least the possibilities are immense. Markets, as we all know, just love where there is good growth, where there are possibilities of sustained Growth. Equities without Growth become like Bonds.

That’s the backgrounder from my side - on setting the ball rolling. I am sure all of us who attempt this will benefit from the exercise, in many ways! So this exercise for me is 3-fold

1. Look critically at the above portfolio; Examine Growth planks/sustainability critically, and weed out/partially/fully-exit growth-valuation mis-matches

2. Focus on the next set of hard work for insights into the best among Opportunistic bets/High Quality bets opportunities that all of us can collectively spot (as valuations become more attractive)

3. While VP will always remain a bottoms-up stock-picking philosophy/strategy, is it possible to make sure we are not on the wrong side of market shifts.

[Donald]

As mentioned, Let’s not put VP Core Team on the spot to justify Allocations in this Portfolio. This is a representative one as any, and based on an individual’s own homework/conviction.

Let’s restrict ourselves to exploring/asking/answering what should be done from here on. What needs to be reduced, what needs to go out, what needs to come in.

Our guess is, the answers will come from homework/confidence/conviction in the growth planks/strong visibility that we can see in these existing or new prospects.

No one has all the answers. But collectively we can be as formidable as we choose to be
If we see enough folks raising their hands here, we will circulate a simple Template to put up our best ideas for exploration/critique/defense by everyone.

A request: just make sure you think twice before posting/asking/replying - No Recommendations;
May be tough to walk the thin line, but we think it can be done if we are alert and disciplined. That’s why once again we are sticking our necks out - in order to help ourselves and our VP readership - to try and make sense of what is happening, not panic but focus on doing the right thing - get back to working hard, this is the best time for that.

[SarangAnajwala]

One strong indicator is that govt expenditure may increase in coming years. The way govt is managing tight fiscal policy, RBI pushing banks to cleanup asset quality, interest rates can come down in next couple of years if inflation holds or keeps coming down and the pace at which govt is doing infra build ups indicate a shift in macro picture towards Infra and Financials.
Now this is macro… VP philosophy has always been bottom up/stock-specific micro picture approach. So I am thinking what are the players in this area of govt spending and financials who can be good couple of years down the line.
Our approach at VP has been primarily growth engines and these sectors (infra/fin) would fit more into contrarian approach.

I have been thinking about SBIs of the world but to be honest I don’t trust my ability to analyze ARs of banks My understanding is limited to good old produce/sell companies and it is very important to be aware of our limits!

Also, another change may be that midcaps and smallcaps have rallied very well in last couple of years. If the biggies like Infra and financials pick due to change in cycle, flow into midcaps and smallcaps may be restricted, especially considering the fact that quite a few are going at decent valuations even after recent correction.

So in nutshell, I feel we need to make space for these sectors. Again, may be a bit shift from our regular approach of growth engine to contrarian approach & midcaps to largecaps so feel free to shoot it down!

[vikskukreja]

Hi Donald,

Thanks for starting this thread. I am sure it will immensely help me to understand portfolio management and how to allocate weight-age to individual stocks.
Can you share philosophy of %age amount to allocate to each company. I am sure it depends on conviction level but would like to know how we can put conviction level to numbers and objectify them. Kelly formula is one way of doing it but I never felt its practical since it always gives higher allocation %age for each stock and will end up with highly concentrated portfolio.

Thanks,
Vikas Kukreja

[Donald]

Let’s explore different viewpoints that come in.

One viewpoint is this idea of shift to Govt led Capex has been in the works for quite some time now in Roads/Highways, Railways in businesses that might benefit from that. Prashant Jain of HDFC was early to call that. By his own admission the Timing wasn’t quite right, and HDFC Funds have underperformed meanwhile. Why are we any closer now? Are these beneficiary firms, starting to show sustainable earnings growth?

On the other hand, they would say that government spending in Defence is there for everyone to see? That has been sustained and showing up in earnings. Are earnings showing up in Transmission and Distribution companies in the Power sector?

Another valid viewpoint is forget the shifts, just focus on signs of sustainable growth for next 2-3 years, as always.

Traveling this week on a family function but also meeting some market veterans on the sides. Will be reporting back on what I learn. No one viewpoint will have all the answers for sure. Will be interesting to learn more on a complex subject, while keeping our VP focus unerringly on sustainable growth picture.

[NNaik]

While investing in ideas that sustain business cycles one approach could be looking for secular trends and companies that benefit from it.

By secular trend I mean irrespective of the macro environment these are broad trends in market that have been set in motion for the past few years and are likely to continue going forward.

Taking a stab to highlight few of these at my end

Value migration trends - two ideas come to mind

1. Growth of efficient private players especially in sectors like Banking. This has been playing out for last 10 years and is likely to continue. What are other sectors that are likely to be in this space. I had started exploring utilities and looking at players like JSW energy, Torrent Power.

2. In the IT sector there is broad trend of IP/Digital led solutions slowly replacing manpower legacy system driven solution. IT companies are facing growth challenges and everyone is busy developing their “digital”/“platform” driven strategy. Those who are earlier into this (CTS) are outperforming more conventional players like TCS. There is opportunity for smart niche players to make significant inroads here. In some ways the barriers to entry are being lowered driven by technology.
   Next 10 years are going to give us new big winners in this space. I am looking at players like Accelya Kale here as next set of winners.

[Vulture]

I appreciate the initiative in starting this thread. My sense is that we should focus on the tasks undertaken by the Govt. and take the lead from those initiatives. Roads, Railways, Infrastructure and Power and Defense come to my mind. The IT and Pharma are more of export driven stories where the global slowdown is a major threat. The frequent USFDA warnings and 483’s are a serious threat to the business and stock performance and are highly unpredictable. The 4 sectors, I would say sunrise sectors of -Roads, Railways, Infrastructure and Power, and Defense would be the biggest beneficiary and provide us the sustainable growth. We need to be focussed on the balance sheet rather than the PnL in these sectors to capture the best companies.

[catchsudipto]

Thanks for such a beautiful writeup.We have many common stocks i.e page gruh pi shilpa. Though i am new to this lovely site and dont have experience & judgement like others but i feel MPS may not qualify as a 25% cagr business growth for next 5 years. But it is a solid business to grow at 16-18 cagr with solid dididentt. I think tata elxsi could be a good bet though very very expensive.
I feel beaten down PSU banks could rally the most in next 1 year and could be a good risky bet. BOB PNB will be my bet.
Can u please explain us why u are soo bulish on shilpa. Please ignore it if its violation forum rules.

[reacher]

we have to decide if we wish to

1. to play the bounce
2. play the compounding stories in new sunrise sectors
3. initially play the bounce and then shift to the compounding stories at higher price

For 1 we have to identify beneficiary sectors like defense,power t&d,roads,infra (top down ) % then identify cos with good fundamentals within these space.We can invite names of cos and also sectors from valuable valuepickr community so that we can arrive at our goal in a structured fashion .

[srnarayan]

To summarize general views domestic infra is going to be good bet…

But what could be the real dark horse and could be a leading indicator would be O&G/Steel and gas-based utilities… My Simple logic is that a 2x thrust on Infra spending should lead to 4x consumption of these products. And valuation-wise these sectors are beaten down to attractive levels.

[MSourabh]

I think the natural tendency of an investor of being optimistic at times could result in either misreading or not at all reading underlying assumptions.

Now, when we talk of market transitions or shifts, it makes perfect sense to remain optimistic for “long term”. Now if the underlying assumption(s) is misread one can get caught on the wrong side of transition which is a generic character of the market transitions. And if not, when the transition is over there will be “return on capital” .

The other possibility is that of not at all reading underlying assumptions. And the outcome could be no “return of capital”. Not because this is a generic character of market transitions but at times there could be exceptions in the character of transitions. And, during such exceptions the short term pain could be devastating because the duration can be longer than expected.

Now what are those underlying assumptions? Well they differ during every transition because the triggers for transitions are always different. Times have changed and the triggers have become multi facet. My only suggestion to novice valuepickrs is that they either be aware of the triggers or remain as spectators while the transition takes place.

But then we as investors should remain optimistic, right?

[Rajesh_R]

I will continue to invest within my circle of competence i.e. secular growth companies. I did not have any success with cyclical and commodity plays - will continue to stay away from them.

[serukulla]

Here are my thoughts on Roads, Railways, Infra, Power and Defense sectors:

1. Most of the projects from these sectors will have long gestation period to complete adding many risks(Project delays due to clearances from various agencies,project cost overruns as we seen in the past).
2. Very capital intensive
3. Low pricing power due to competition or due to political reasons
4. Historically I did not see many good companies returning good returns in the above sectors.

But as a proxy to them we can look at good quality cement, steel or any other which will consumed by them.

Please add counter thoughts

[sandriano]

Thanks Donald for initiating this thread! Market transitions are very interesting to study and presents an opportunity to become wiser.
If we look back in time at our markets we had major transition points in 2000, 2008 and now (seemingly) in 2016. It seems to occur roughly at every 8 yr interval. During 2000-08 we saw rupee appreciate (relative to US dollar). This period was also marked by remarkable rise in crude oil prices (and despite this rupee appreciated) and decline in domestic interest rates. We also had the famous EM (emerging markets) bull run during 2004-2008. The leading sectors during this bull run were mostly domestic in nature like Infrastructure / Realty, PSUs, capital goods, power, metals, auto, etc., Most of these were related to capex. You would have been mocked at in 2002 if you had suggested L&T and BHEL as potential investment ideas then. An important point to note during this period is that though EM went on to make new highs the most developed market did not scale their 2000 highs. But the trend changed in 2008 and developed markets took over the mantle of leadership. And during the next 8 yrs (2008-16) most developed market scaled their 2000 highs and made new highs. Notably Nasdaq breached high after 15 yrs.
Back in India during these 8 yrs, we had to deal with high inflation, high interest rates and the rupee depreciation. The market leadership changed from domestic based theme to export oriented sectors, notably pharma. Even though we scaled 2008 highs it did not mean much in dollar terms. If we observe the BSE Dollex the market is yet to scale 2008 high in dollar terms.

(Just to buttress the point of rupee depreciation and market leadership, it is pertinent to note that in the 8 yr cycle before 2000 there was major bull run in pharma and IT during 97-99. I still vaguely remember Dr. Reddy’s and Aurobindo making new high almost on a daily basis. And we all know the now famous heavenly run the IT stocks had in this period).

Now in 2016 we again stand at a major transition point in the market. The pendulum of leadership in world market will shift away developed market, notably towards India. Before we start analyzing about potential market themes, we should pause and pay a little attention to what this government is upto. They have been harping on bringing in the next wave of green revolution, making housing affordable to lower middle class, making the textile industry competitive (?), Make in India, electrifying even the remote region (UDAY), crop insurance, StartUp India, etc., Now if all these have fructify there is a lot of capital expenditure involved. So, what is the government doing about? Luckily it got a bonanza with falling crude oil prices and is here to stay for considerable time. Displaying great fiscal prudence they haven’t loosened the purse immediately at the cost of the consumer. The domestic fuel prices might see drastic reduction in 2018 (if crude stays below $50). Also they have an excellent RBI governor (and the previous one as well) who has steered through the high inflation regime very well which, IMHO, has laid a great platform for better economic times in coming future. Add to this, we are now in a falling inflation, falling interest rates and arguably in a commodity downturn for sometime to come. If this hypothesis is correct then we should see rupee appreciate and along with long term gilts for next 18 months. We have already seen great appetite from FII for our G-Secs in recent past.

One last point before I narrow down on the potential themes/sectors for the next bull run. I know for sure that stocks from themes/sectors which emerge as leaders for the next bull run do not make 52 week lows during the transition point (like the one we are witnessing now). They would have already done that sometime ago and stubbornly resist any downfall. That’s because the smart money would have already got into these sectors a while ago and they are just waiting for the bull run to start. (Bellwether stocks from such sectors should used to check this hypothesis).

Finally with this background let us look at themes/sectors which fit this bill. New themes/sectors emerge for every bull run. The themes that would broadly fit are agrochemicals/fertilizers and agriculture related, power sector, defence, housing finance (small ticket, could be few NBFCs as well) and sectors related to discretionary spending (e.g. entertainment). These are the sectors that I could figure out. Some opportunities could be found in chemical/commodity sectors where crude is a major input but these would only serve as opportunistic bets given that we are in for a long haul crude meltdown. Textile also seems to fit the bill but I am skeptical due to the cyclical nature of the sector.

Note: The above inferences are only for academic purpose and should not be taken as investment advice

Regards
Roberto el S

[longinvest]

Hi Donald, Thanks for starting this thread - a great opportunity to learn for newbies like me!

When we think about portfolio restructuring in 2-3 years, we are indicating churning of stocks in the same time frame. If this exercise continues for a fairly long period of time, we will be churning the portfolio many times over. The result is likely that we know of a number of high-quality stocks but hardly get the ‘right’ entry/exit points of each.

Restructuring boils down to the basic thesis of when to sell: if the price justified by fundamentals is too high; or if the fundamentals are deteriorating; or if we get a better risk-reward opportunity over a long time frame.

Below is a timely and insightful article revealing the holding periods of top investors.

Focus On The Long-Term - MicroCapClub

That being said, coming back to your poser on portfolio restructuring candidates, please let us know which ones should be discarded/reduced based on new assessment of the fundamentals and/or valuation.

Please forgive my ignorance - I am very much a newbie and learning the ropes of investing as an amateur.

[abhishek90]

Hi Donald,

Wonderful work done.

As rightly pointed out by Robert and others the following sectors might have a tailwind for the coming years -

1). Power Sector.
2). Infrastructure Sector.
3). Agro chemical and other agri related sectors.
4). Affordable housing sectors.
5). Textile Sector.
6). Micro finance Sector - largely due to higher agriculture related subsidies declared by govt for this year.
7). Digital India Stories.

I feel sectors that are low crude price beneficiaries - the plastic industry for example are cyclical stories, on which we should not rely much because both entry and exit will have to be taken care of.
I feel that infra business in india can not generate wealth for the investors - due its inherent nature specified above by one of the VP member. (correct me if i am wrong here).
I feel we should play on the MFI/affordable housing/Agro chemicals themes - catch companies having good market share/leadership in the segment/moat available at decent valuations.
Other than this we should play stock specific in textile/auto and other sectors.
Pharma sector is going big and big over years. We should be there in pharma over coming years. The sector has huge growth potential.

I am least experienced and learning from other VP members. Contrary views are invited.